As interest rates reach levels not seen in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks linked to their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to address potential losses from credit risks, including overdue loans and bad debts, particularly in commercial real estate (CRE) lending.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for such losses totaled $21.8 billion by the end of the quarter, marking more than a threefold increase from the previous quarter’s reserves. Wells Fargo accounted for $1.24 billion in provisions.
These increased reserves reflect banks preparing for a riskier landscape, where both secured and unsecured loans could lead to significant losses. A recent report from the New York Fed indicates that U.S. households collectively owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and the rates of delinquency are also on the rise as individuals exhaust their savings accumulated during the pandemic and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter in which totals surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, remarked on the residual effects of COVID-related stimulus on the economy’s health and consumer confidence.
However, banks are primarily focused on future challenges. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not solely reflect existing credit quality but are more a prediction of prospective risks.
As banks forecast slower economic growth and higher unemployment, they anticipate potential delinquencies and defaults later this year. Narron expects interest rate cuts in September and December, which could further exacerbate credit challenges.
Citi’s Chief Financial Officer Mark Mason highlighted that stress indicators are particularly evident among lower-income consumers, whose savings have diminished since the pandemic. He noted a disparity in financial behavior, indicating that only the highest income quartile has greater savings now compared to 2019.
The Federal Reserve has maintained interest rates at a high of 5.25-5.5% in hopes of stabilizing inflation near its 2% target before implementing expected rate cuts.
Despite the banks’ preparations for potential defaults, Mulberry noted that current default rates do not indicate an impending consumer crisis. He pointed out the contrasting situations of homeowners, who benefited from historically low fixed rates, versus renters who are feeling the financial strain of rising housing costs.
While rent has increased over 30% nationally since 2019 and grocery prices have surged 25%, renters face significant pressure on their budgets, as many did not secure low mortgage rates during the pandemic.
Overall, the recent earnings reports from banks indicated no significant change in asset quality. Strong revenues and resilient net interest income suggest that the banking sector remains healthy, although the persistence of high interest rates could lead to increased stress in the future.